Table of Contents
Foreword xvii
Preface xix
Highlights of This Book xix
Who Should Read This Book? xix
About the Book xix
Acknowledgments xxiii
PART I FOUNDATIONS: VALUING A BUSINESS 1
CHAPTER 1 Fundamental Concepts for Defining Value 3
Standard of Value 3
Level of Value 9
Premise of Value 11
Conclusion 12
CHAPTER 2 Defining the Engagement 13
The Importance of Defining the Engagement 13
Defining the Client 15
The First Call 15
The Subject Entity and Entity Type 16
Entity Distinctions and Entity Significance in the Valuation 18
State of Entity Organization or Incorporation 19
Principal Business Location 19
Description of the Subject Interest 20
Purpose and Intended Use of the Valuation 21
Date of the Valuation 23
Scope of the Work Product 24
Summary Assignment Definition Table 26
The As-Of Date of the Appraisal and the Date of the Appraisal Report—Added Thoughts and Perspective 26
Conclusion 28
CHAPTER 3 Information Collection and Due Diligence 29
Importance of the Information Collection and Due Diligence Phase 29
Industry and Economic Considerations 30
Financial Information and Analysis 31
The Management Interview 35
Preparation 37
Agenda of a Typical Management Interview 38
Conclusion 40
CHAPTER 4 An Overview of Valuation Approaches 41
Recognized Valuation Approaches 41
Methodology and Level of Value, Direct and Indirect Methodology 42
CHAPTER 5 Valuation Approaches: The Cost Approach 47
The Cost Approach 47
Typical Adjustments in the Cost Approach (Using Tangible Net Asset Value Methods) 53
To Tax Affect or Not 54
CHAPTER 6 The Income Approach to Value 59
Direct Capitalization and Discrete Projection Methods 60
Reconciliation of Income Methods to Market Methods 61
Typical Adjustments to the Income Statement 62
Adjustments That Correspond to Balance Sheet Treatments 63
Reconciling or Reclassifying Interim-Period Measures to Fiscal-Period Measures 63
Income Statement Adjustments and Considerations 65
Matching the Cost of Capital to the Benefit Stream 69
Developing the Cost of Capital 70
Summary Examples of Developing the Cost of Equity Capital 74
Growth Rate of Earnings/Net Cash Flow 77
Finishing the Direct Capitalization Equation 83
Developing the Single-Period Benefit (Ongoing Earnings and Ongoing Net Cash Flow) and Preparation for the Discounted Future Benefits Method 84
Example of a Single-Period Capitalization to Derive the Market Value of Total Invested Capital 86
The Discounted Future Benefits Method (DFB) 88
Conclusion 93
CHAPTER 7 The Market Approach 95
Valuation Methods under the Market Approach 96
Rules of Thumb 97
Transactions Method 98
Guideline Public Company Method 99
The Fundamental Adjustment 105
Guideline Transactions Method 110
CHAPTER 8 Correlation of Value 113
Global Considerations in the Correlation Process 113
Examples of Correlating a Value Indication 118
Conclusion 124
CHAPTER 9 Valuation Discounts and Premiums 125
The Levels of Value Revisited 125
Perspective on the Control Premium 127
Control Premiums—Substance Over Form 129
Perspective on the Minority Interest Discount 130
Marketability Discounts 132
Conclusion 133
PART II BUSINESS VALUATION STANDARDS 135
CHAPTER 10 Uniform Standards of Professional Appraisal Practice (USPAP) 137
Overview of USPAP Valuation Standards 138
USPAP Ethics Rule 139
2010–11 USPAP Competency Rule 140
2010–11 USPAP Scope of Work Rule 141
2010–11 USPAP Jurisdictional Exception Rule 142
USPAP Business Appraisal Review (USPAP Standard 3) 142
Business Appraisal Development: USPAP Standard 9 146
Business Appraisal Report Standards USPAP Standard 10 148
USPAP Certification Requirement 149
USPAP Statements on Appraisal Standards and Advisory Opinions 150
CHAPTER 11 American Society of Appraisers (ASA) Business Valuation Standards 153
ASA BVS General Preamble 153
ASA BVS-I (General Requirements for Developing a Business Valuation) 154
ASA BVS-II (Financial Statement Adjustments) 156
ASA BVS-III (Asset-Based Approach to Business Valuation) 156
ASA BVS-IV (Income Approach to Business Valuation) 157
ASA BVS-V (Market Approach to Business Valuation) 158
ASA BVS-VI (Reaching a Conclusion of Value) 159
ASA BVS-VII (Valuation Discounts and Premiums) 159
ASA BVS-VIII (Comprehensive Written Business Valuation Report) 160
ASA BVS-IX (Intangible Asset Valuation) 161
ASA SBVS-1 (Guideline Public Company Method) 161
ASA SBVS-2 (Merger and Acquisition Method) 162
PG-1 (Litigation Support: Role of the Independent Financial Expert) 163
PG-2 (Valuation of Partial Ownership Interests) 163
CHAPTER 12 The American Institute of Certified Public Accountants (AICPA) Statement on Standards for Valuation Services 165
Introduction and Scope 165
Overall Engagement Considerations 165
Development 168
Valuation Approaches and Methods 170
Detailed Report 176
Summary Report 180
Calculation Report 181
Oral Report 181
CHAPTER 13 National Association of Certified Valuation Analysts (NACVA) Professional Standards 183
Preamble—General and Ethical Standards 183
Valuation Services 184
Development Standards 184
Reporting Standards 185
Miscellany 186
CHAPTER 14 The Institute of Business Appraisers (IBA) Business Appraisal Standards 187
Standard One: Professional Conduct and Ethics 187
Standard Two: Oral Appraisal Reports 190
Standard Three: Expert Testimony 190
Standard Four: Letter Form Written Appraisal Reports 191
Standard Five: Formal Written Appraisal Reports 192
Preliminary Reports 193
CHAPTER 15 Canadian Institute of Chartered Business Valuators Practice Standards 195
Practice Standard 110—Valuation Reports 195
Practice Standard 120—Scope of Work 198
Practice Standard 130—File Documentation 200
Practice Standard 210—Advisory Reports 201
Practice Standard 220—Scope of Work for Advisory Reports 202
Practice Standard 230—File Documentation for Advisory Reports 202
Practice Standard 310—Expert Reports 202
Practice Standard 320—Scope of Work for Expert Reports 204
Practice Standard 330—File Documentation Standards in Expert Reports 205
Practice Standard 410—Limited Critique Reports 207
Practice Standard 420—Scope of Work for Limited Critique Reports 209
Practice Standard 430—File Documentation Standards for Limited Critique Reports 210
Practice Bulletins 210
CHAPTER 16 Internal Revenue Service (IRS) Business Valuation Standards 215
IRM 4.48.4.1—Introduction 215
IRM 4.48.2—Development Guidelines 215
IRM 4.48.4.3—Resolution Guidelines 218
IRM 4.48.4.4—Reporting Guidelines 218
Addendum A USPAP 3 Comparison Chart 219
Addendum B USPAP 9 Comparison Chart 220
PART III LESSONS FROM THE TRENCHES 221
CHAPTER 17 Alleged Errors of Omission by Appraisers 223
Failure to Comply with USPAP 224
Valuation Credentials 225
Too Much Involvement by Counsel in the Appraisal Report Preparation 225
Standard of Value 225
Valuation Date 226
The Subject Property Interest 227
Bias 228
Sources of Data 229
Independence 230
Pure Reliance on Case Law 230
Site Visits and Management Interviews 231
Failure to Provide Sufficient Explanation 232
Disregard of Material Facts 232
Failure to Find Available Information 233
Failure to Adequately Support Selection of Beta 234
Improper Sampling Techniques 235
Off Financial Statement Items 236
Failure to Sufficiently Explain Assumptions 236
Insufficient Due Diligence 237
Failure to Make Inquiries with Significant Third Parties 237
Failure to List All Appraisers’ Qualifications 238
Failure to Consider the Small-Stock Premium 238
Failure to Factor in Income Tax 239
Failure to Set Forth the Adjustments to Financial Statements in the Appraisal Report 239
Failure to Produce a Replicatable Report 240
Failure to Identify the Multiples Selected 240
Failure to Discuss Weightings in the Appraisal Report 240
Failure to Distinguish between Tax and Book Depreciation 240
Failure to List Guideline Companies 241
Failing to Separate Operating and Nonoperating Aspects of a Company 241
Failing to Lay Foundation for Small Stock Premium 241
Failing to Justify Capitalization or Discount Rates 242
Failure to Think Like an Investor 242
Failure to Define Capital Structure 243
Failure to Adequately Consider the ‘‘Willing Buyer’’ 243
Failure to Adequately Consider the Willing Seller 243
Failure to Accurately Describe the Subject Property 244
Failure to Properly Classify the Subject Company 244
Failure to Explain the Basis for a Valuation Discount 245
Failure to Properly Consider the Subject Company’s Growth Rate 245
Failure to Explain Market Multiples Selected for Guideline Companies 245
Failure to Explain Equal Weighting of Conclusions of Value 246
Failure to Consider Differences between the Subject Company and the Guideline Companies 246
Failure to Utilize Data from a Guideline Company That the Appraiser’s Own Summary Chart Reflects Is
Closest to the Subject Company 246
Failure to Explain the Selection of the Range of Performance Ratios Selected 246
Failure to Adequately Explain Why Companies Selected as Guideline Companies Are in Fact
Comparable to the Subject Company 247
Failure to Explain Why So Few Comparable Properties or Guideline Companies Were Selected 247
CHAPTER 18 Alleged Errors of Commission 249
Retrospective Appraisals 249
Use of Past Publications of an Appraiser against the Appraiser 250
Using Untested Methodology 250
Improper Reliance on a Draft Appraisal 251
Conclusion of Value Offends Common Sense 251
Mathematical Errors 252
Inconsistency 253
Double Counting 253
Conflicting Conclusions of Value 254
Sole Reliance on a Valuation Model 254
Incorrect Usage of Discounted Cash Flow Method 256
Skewed Assumptions 256
Overemphasis on Buy-Sell Restrictions among Related Parties 256
Using Historic Book Value of Assets in Net Asset Value Approach, Even Though Asset Appraisals
Had Been Obtained 257
Misapplication of Pre- and Post-Tax Figures 257
Ignoring the Hypothetical Nature of the Willing Buyer or Willing Seller 257
Inconsistent Use of Commercially Available Data 258
Use of Commercially Available Data That Warns of Statistical Inaccuracy 258
Misstatement of Methodology Employed by Appraisers on Whose Work the Appraiser Has Relied 259
Undue Reliance on the Work of Another Appraiser 259
Using a Valuation Method without Laying a Foundation That It Is a Legitimate Method (for Example, the
Business Broker Method Using Data from the IBA Market Database) 259
Improper Reliance on a Study That Does Not Completely Provide All Relevant Data 260
Failure to Apply Discussion of Economic Factors to the Subject Company 260
Using Commercially Available Data in a Manner Contrary to How the Data Source Says the Data Should Be Used 261
Failure to Proofread Report Prior to Issuance 261
Apparently Conflicting Assumptions Used for the Same General Purposes without Sufficient Explanation 261
Use of Different Valuation Methods in Valuing the Same Interest in Valuation Reports Offered at
Different Times without Adequate Explanation 262
Making Improper Adjustments to Financial Statements 262
Reliance on the Pre-IPO Studies and the Restricted Stock Studies to Determine the Discount for Lack of
Marketability for a Controlling Interest 263
Misreading or Failing to Properly Consider Revenue Ruling 59–60 263
Failure to Accurately State the Number of Shares Outstanding in the Subject Company 264
Inconsistency in Valuation Methodology Expressed in Testimony versus the Appraiser’s Methodology as
Expressed in another Writing 264
Unreasonably Low Projections 264
Failure to Add Back Depreciation Included in Costs-of-Goods-Sold Computation in the Computation of EBDIT 264
Combining the Discount for Lack of Control with the Discount for Lack of Marketability 264
Utilizing an Assumed Income Tax Rate That Differed from the Actual Past Tax Rates of the Subject Company 265
Disconnect between Assumption about When Revenues or Expenses Would Be Received or Incurred and When Those Items Were Actually Received or Incurred 265
Error in Computing Terminal Value When Using the Income Approach 265
Discounting an Income Stream Only at or Close to the Risk-Free Rate 266
Modifying or Abandoning Positions Taken in the Written Appraisal Report during the Appraiser’s Testimony 266
Referring to a Standard Industrial Code in the Appraisal Report without Identifying That Number in the Report 267
Relying upon Guideline Companies That Were Not Comparable to the Subject Company 267
Preparing and Utilizing Earnings Projections That Vary Significantly from the Earnings Projections Prepared by the Subject Company 268
Use of Only One Year’s Worth of Guideline Company Data 269
Inappropriate Employment of a Discount to Make a Conclusion of One Valuation Approach Appear
More in Line with Another 269
Failing to Properly Calculate a Valuation Discount 269
Inappropriate Use of a Price-to-Asset Multiple Where the Difference between Book Value and Asset Fair
Market Value Is Not Close 270
Selection of Too Few Guideline Companies or Comparable Properties 270
Selection of Too Few Performance Measures in the Guideline Company Method 270
Cherry Picking Valuation Multiples 271
Using an Inexcusably Old Comparable Sale 271
Inappropriate Reliance on Governance Document
Restrictions in Establishment of Valuation Multiples 272
Stating the Wrong Date from a Comparable Sale 272
Mismatching the Valuation Dates of the Guideline Companies and the Subject Company in Computing
Price Multiples 272
Defining ‘‘Guideline Company’’ Too Narrowly 273
CHAPTER 19 Ten Burning Issues within the Appraisal Profession 275
Issue 1: Methods of Determining the Discount for Lack of Marketability 276
Issue 2: Applicability of Discount for Lack of Marketability to a Controlling Interest 286
Issue 3: Validity of Discount for Imbedded Capital Gains 288
Issue 4: Shift of ‘‘Comparability’’ from the Publicly Traded Arena to the Private Arena 289
Issue 5: Efficient Market Hypothesis and Exceptions (For Example, Small-Firm Effect) 290
Issue 6: Value of Control versus Value of Synergy 291
Issue 7: Do Public Company Stock Prices Indicate a Marketable, Minority or a Marketable,
Control Position? 298
Issue 8: S Corporation Tax-Affecting 299
Issue 9: Factoring Financial Statement Adjustments When Estimating the Value of a Noncontrolling
Interest 301
Issue 10: Validity of the Capital Asset Pricing Model for Valuing Interests in Closely Held Businesses 301
Conclusion 303
CHAPTER 20 Random Practical Valuation Tips and Thoughts 305
Discovery and Privileges 305
Attorney-Client Privilege 307
Attorney Work Product Privilege 308
Tax Practitioner Privilege 309
A Free Standing, Complete Report, or a Mere Letter or Restricted Use Appraisal Report? 309
Those Business Appraisers Must Be Identified in Time 311
Should a Business Appraiser Always Follow USPAP? 311
How Much Input Can a Client’s Advisor Have in the Preparation of a Business Appraisal Report? 312
Types of Appraisers; Appraisal Associations 312
Random Strategy Tips 315
APPENDIX A Appraisal Standards Chart 321
APPENDIX B Information Request List 325
APPENDIX C Management Interview Checklist 327
APPENDIX D Sample Engagement Letter 329
Glossary 335
Bibliography 343
Business Valuation Texts 343
Business Valuation Journals and Newsletters 344
Cost of Capital 345
Equity Risk Premiums 345
Articles 346
About the Authors 361
About the Web Site 363
Index 365
